Debt consolidation is a popular way to manage debt, but it's not always the best option. Before you decide to consolidate your debt, it's important to understand how it works and what the potential impacts on your credit score may be. Debt consolidation involves taking out a loan to pay off other debts, such as credit cards or medical bills. This can be done through a personal loan or a balance transfer credit card.
When you consolidate your debt, your credit is checked, which can lower your credit rating. Consolidating multiple accounts into a single loan can also lower your credit utilization rate, which can also hurt your rating. Payment history represents approximately 35% of your credit score. If you already have a strong history of on-time payments, debt consolidation may not affect this aspect of your credit score.
But if consolidating your debts into a new loan at a lower interest rate will make it easier for you to make timely payments, debt consolidation could help improve your credit score in the long term. If you get a consolidation loan and keep making more purchases with credit, you probably won't be able to pay off your debt. If you have problems with credit, consider contacting a credit counselor first. When you apply for a new credit account to consolidate the debt, the lender will check your credit, which will lead to a so-called hard consultation on your credit report. Each firm consultation can temporarily lower your credit score by up to five points, as lenders consider new credit applications as a sign of risk. A bankruptcy filing, on the other hand, definitely hurts your credit scores.
The damage you will cause depends, in large part, on how good your credit was before you applied. If you are delinquent on many accounts before filing your return, your credit will already be in disrepair. If you later file for bankruptcy, your score will drop, but not as much as if your credit was good before filing for bankruptcy. If you file for bankruptcy when your credit is good, your score will suffer much more after filing. Depending on the type of bankruptcy case you file, the filing can stay on your credit reports for seven to ten years.
But filing for bankruptcy could also help your credit, such as improving your debt-to-credit ratio, getting rid of delinquent accounts, and giving you a chance to start rebuilding your credit. Consolidating your debt can affect your credit rating, but as long as you manage your debt responsibly, any negative effects will be temporary. If all goes well (and that's a big yes), you should be able to pay off your debts in cents on the dollar. But before moving forward with this method of debt relief, it's important to understand what it does to your credit, how the process works, and your other options. Consolidating your debts could end up costing you more money in the long run and, if the debt is insured, you could lose some property. If you're trying to decide if debt consolidation is a good idea, start by looking at your overall financial life. Consolidating your debt can lower your monthly payments, but it can also cause a temporary drop in your credit rating. Below is a more detailed analysis of the potential impact on your credit when consolidating debt with a personal loan or balance transfer credit card, as well as other debt consolidation options.
Consider all of these factors before making any decisions about consolidating debt.